March 1, 2006

CBOE, HedgeStreet Form Partnership

CHICAGO (HedgeWorld.com)--HedgeStreet Inc., purveyor of futures and binary options called Hedgelets, is getting a major infusion of capital and credibility thanks to a new joint venture with the Chicago Board Options Exchange.

As part of the deal, announced today [Feb. 22], the CBOE will make a seven-figure equity investment in HedgeStreet, provide the company with access to its technology services and help with marketing and support of the Hedgelet products. Additionally, HedgeStreet will get increased visibility via a link on the CBOE's popular web site, and access to the deep liquidity of the exchange's market makers.

In return, the CBOE instantly becomes a player in what it believes is a growing area of the derivatives world: binary options. Such contracts have two possible outcomes, either they finish in the money or out of the money. They are sometimes referred to as "yes or no" or "cash-or-nothing" options. CBOE also will tap into HedgeStreet's order matching technology, which HedgeStreet officials say has nearly boundless capacity.

In addition to the binary options, HedgeStreet also offers futures Hedgelets, which allow traders to take positions on market directions and which have sliding payoffs based on how much the market moves. As part of the agreement, the CBOE and HedgeStreet will work together on retail distribution of all its Hedgelets through joint marketing initiatives. They will also share technology and hosting facilities.

"We believe the products HedgeStreet offers are the avant garde of financial products," said William J. Brodsky, chairman and chief executive of the CBOE, at a news conference.

John Nafeh, chairman and co-founder of HedgeStreet, said the bottom line of the new partnership is increasing the number of asset classes listed on HedgeStreet, expanding the number and variety of derivatives being traded and providing millions of retail customers access to those derivatives.

He said HedgeStreet, which closed about a million contracts last year in its first year of operation, could have grown on its own, but partnering with the CBOE will rapidly speed up the process.

CBOE will host HedgeStreet's trading system, opening it instantly to a new and larger audience. Likewise, HedgeStreet will list CBOE products on its system. Together the two will work to develop new products.

Steven Race, HedgeStreet's recently-hired chief executive, said his firm gets an additional benefit right away: "There is also a legitimacy. CBOE brings an implied endorsement [for HedgeStreet]."

Patrick Fay, managing director of the CBOE Futures Exchange, said the CBOE's product development committee identified binary options as the next wave in financial products. "We believe it has great promise," he said. "This is a business we had to get into."

And while the CBOE could have built its own platform, it seemed more practical to partner with a firm that was already well along the development path.

Mr. Fay said he expects a number of the CBOE's liquidity providers will make markets in Hedge Street products, just as many HedgeStreet customers also have traded securities options on the CBOE. Hedge fund managers are a prime target of the new partnership, because both sides believe that there is a strong market there for binary products.

Russell Anderson, HedgeStreet's co-founder and vice president of instrument origination, said the hedge fund world is changing fast, and managers are looking for new ways to generate alpha. "The community is hungry for new ideas and products," he said. "We want to expand the range of products for hedge funds."

Mr. Brodsky declined to discuss specifics of the CBOE's equity investment, other than to characterize it as a seven-figure amount and add that Norwest Ventures Partners, the private equity arm of Wells Fargo, also invested. "We have a very large incentive to see this be successful," Mr. Brodsky said.

HedgeStreet's Hedgelets take two forms. Binary options allow traders to take a position relative to some outcome. For instance, crude oil Hedgelets offer a range of strike prices from US$61 per barrel to US$64 per barrel. The trade entails deciding whether oil will be above or below the strike price at the end of a certain time period. Buyers take the position that the strike price will be reached, sellers take the position that it will not. For as little as US$10, traders can take a position. The payout is fixed--US$10 if the bet is right, US$0 if it's wrong--and there is no margin, which means traders can't lose more than they wager.

With the futures Hedgelets, contract prices vary in price up to US$50. The payoff is based on the ending level of the price of the underlying asset. If the price ends below the floor, the payout is US$0 for the buyer and whatever the stated contract size is--up to US$50--for the seller. If it ends above the cap, the payout is reversed. And if it ends in between, the payout varies. For example, take a US$30 crude oil Hedgelet future on a price range of between US$50 and US$80 per barrel. If the price ends at US$67 per barrel, the buyer receives US$1 for every dollar above the US$50 per barrel price, or US$17. The contract seller receives US$1 for every dollar below the US$80 per barrel price, or US$13, according to the HedgeStreet web site.

Members can open an account for US$100. Trades are matched through HedgeStreet's own order matching system.

Currently HedgeStreet offers binary options Hedgelets on currencies, employment, metals, commodities fuel, housing prices, inflation, interest rates, and mortgage rates. Futures are available to trade in commodities, currencies, fuel and housing prices.

At the news conference, Mr. Nafeh also addressed the meaning behind HedgeStreet's logo, which is a series of green, blue and yellow pick up sticks. According to mythology, ancient seers were able to see through the dropped sticks and read the future. "Reading the future is very important in risk management," he said, smiling.

CClair@HedgeWorld.com

Contact Bob Keane with questions or comments at bkeane@investmentadvisor.com.

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